Q2 2020 Asia and China outlook - Riding out the Storm

AXA Investment Managers (AXA IM) observes that the outbreak of the Covid-19 coronavirus has created enormous levels of uncertainty about the economic direction of both China and Asia more broadly.

At a media briefing on 26 May 2020, three AXA IM specialists discussed the impact of the virus outbreak and what they expect to see in 2020 in the China macro, Asia equity and credit markets.  

Feel free to read the key highlights below, or scroll down to watch the playback.

1) China’s macro economy – Giving the Recovery an Extra Policy Kick


Aidan YAO, Senior Emerging Asia Economist

Three phases of Covid-19 effects on the Chinese economy

  • The plunge:
    • China’s economy sees plummeting consumption as Beijing locks down the economy – home sales and coal consumption by electricity suppliers falls off to nearly zero.
  • Supply normalisation:
    • Aggressive controls and mandatory social distancing prove effective, so by mid-February conditions outside Hubei Province have improved notably, allowing other provinces to relax controls and production to resume. Industrial sectors recover much more quickly than those related to consumers and services; large businesses recover much faster than SMEs; supply recovers much faster than demand.
  • Demand resumption:
    • Begins around the end of March, with the supply shock having dissipated but the economy not roaring back mainly because of demand deficiencies persisting.

Comparison with previous crises

  • Chinese economy contracted 6.8% - a rate unprecedented in modern history; China’s economy took a 3.4% hit during the Asian Financial Crisis during 1997-99 and shrunk 5.1% as a result of the Global Financial Crisis of 2008-09. Such a severe shock was in part a result of China taking more aggressive action to control the outbreak than other countries.

The aftermath

  • Bottleneck has shifted from supply side of China’s economy to the demand side; very clear jump in Chinese unemployment in past couple of months; figures make this clear but possibly underestimate the pain in the Chinese labour market.
  • Dropoff in consumer spending, attributable to very notable decline in wage growth amid concerns over job losses and salary cuts.

Overcoming the economic hurdles

  • Economic downturn unlikely to be resolved very quickly, with local and global weakness persisting for a long period.
  • To hasten recovery, China’s economy requires intervention by policy authorities; Beijing was the earliest and fastest to step in to provide growth stimulus, but in both monetary and fiscal policies, China has lagged the rest of the world, with most developed countries having provided support for growth. Two reasons for this: 1) people not returning to work; and 2) approval for fiscal stimulus was required from National People’s Congress, which was delayed by around two-and-a-half months. Both constraints now removed.

Net effects

  • Covid-19, global demand and second-order effects together wipe 11.8% off China’s GDP growth as pent-up demand and policy stimulus offset this by 7.8%, leading to a 4% hit to GDP growth; this will take growth from last year’s 6.1% to 2.1%, which is close to AXA IM’s current forecast of 2.3% for full-year 2020.

Three risks

  • More viral outbreaks; already some further outbreaks and consequent lockdowns, albeit less severe than initial shock.
  • Policy easing; could be insufficient or excessive.
  • A “new season of old drama” as the China-US trade war is rekindled, extending beyond trade and into technology, financial markets and geopolitics; run-up to November’s US presidential election likely to be particularly volatile and impact financial markets.

2) Asian equity - Has COVID Changed the Game?


Simon WESTON, Senior Portfolio Manager, Asian Equity

Uncertainty abounds, but long-term outlook will guide us

  • Covid-19 has generated a lot of uncertainty about the economic outlook, but we remain focused on the long-term structural trends and themes that we see as continuing to play out even against this more uncertain outlook.
  • There has been considerable continuity in many of these trends from the pre-Covid-19 era, and indeed the outbreak has accelerated and reinforced many of them across the region.

US/China tensions

  • Geopolitical tensions have risen, but this has been an issue for much of the past 18-24 months; these tensions are as much to do with the trade war as jostling for technological leadership, which Covid-19 has boosted.

De-globalisation

  • The trend towards localization and away from globalisation has accelerated; this has been seen in the US and the West in particular, especially in technology but also in other industries such as pharmaceuticals; Vietnam and Taiwan are particular beneficiaries, although these shifts were already under way and are not entirely attributable to the pandemic.
  • The outcome is the unwinding of supply chains that have built up over many years; Asia is unlikely to lose out entirely as a result of this, but one probable outcome will be higher production costs associated with onshoring to Europe and the US.

Asia will remain a growing source of equity and income

  • Covid-19 has had consequences for bond yields and interest rates, which have sunk to unprecedented low levels; investors everywhere are searching for yields, and Asia’s attractiveness as a source of equity yield should only increase as a result of this.
  • Covid-19 has made certain investment themes even more compelling than they already were:
    • E-commerce and the rise of fintech and cashless societies, where Asia leads the world in many respects; China has seen very rapid uptake of fintech, with third-party payment industry growth of more than 100% annually during the past six years and no signs of a slowdown.
    • Asia as a whole has been an early adopter of fintech and cashless payment, dwarfing the US and leapfrogging traditional banking as consumers to go directly to e-finance.
    • The centrality of technology to working and living.
    • Rising health spending, both personally and publicly, and including growing interest in insurance – especially protection and health, partially reflecting ageing populations but also as a result of the virus.
    • The increased use of robotics, partly driven by ageing populations and slower workforce growth; China is the biggest user of robots globally.
    • An increased focus on food safety.
  • Setbacks have obviously occurred in travel and tourism.

What next?

  • Analysis suggests that Asia ex-Japan boasts the second-highest proportion of safe dividends after the US, reflecting a very high level of cash backing and strong balance sheets, which means companies are in a good position to maintain and potentially even increase dividends – though an exception is Australia where many companies have cut dividends in order to preserve cash.
  • With many companies in other parts of the world cutting dividends, notably in Europe, this means that many sources of income for equity investors is disappearing, and that can only increase the attraction of Asia.
  • Covid-19 will continue to cause disruption, but from our point of view, one key outcome is an acceleration of key trends that were already under way and already driving a large part of our investment process – and, more importantly, a reinforcement of many existing investment themes that we see as continuing to be extremely attractive. So even against a backdrop of considerable uncertainty, from a long-term, perspective, there’s a lot of appealing opportunity in Asia.

3) Asian Credit Market Dislocation


Jim VENEAU, Head of Asian Fixed Income

Investment impact

  • Covid-19 has had a clear impact. We have to ask how much permanent damage has been done to Asian credit markets in such a short period; credit markets are implying a substantial amount
  • We can see this because what can be cured by liquidity has recovered and what can’t hasn’t; that’s neither good nor bad – but it’s an indication of where the market feels there’s distress.
  • We’ve seen an historic drawdown followed by a sharp but incomplete recovery. Big sections of the market remain in negative territory, with recovery remaining uncertain.
  • The dislocation we’re seeing is apparent at the country and sector level – it’s also apparent at the individual bond level; there are large numbers of distressed bonds. There’s likely value in this group, but also damage from the virus impact, meaning that a number of companies are having to restructure.
  • So how bad was it? High-yield was down more than 15% at the low point in the market, which was around March 23-24. It’s recovered more than 11% off its low, so that’s a nice, and fairly sharp recovery. Investment-grade was much less impacted – that’s not surprising. The other thing benefiting the investment-grade market has been US Treasury yields, which have come down in this period, so that’s been a bit of an offset in that sector. 
  • Overall, investor sentiment continues to support markets, as does a favourable technical balance between the supply and demand of bonds.
  • This support will continue to be uneven, leaving considerable dislocation among bonds and even entire sectors; as a result, large swaths of cheap bonds exist, but ultimate value will depend on issuer fundamentals and even solvency considerations.